Jonathan Guyton: What the Crisis Means for Retirement Planning

Jan 02, 2024

A noted retirement researcher and financial planner discusses the benefits of Treasuries in retirement, putting guardrails around withdrawals, and why discretionary funds work.

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Our guest on the podcast this week is Jonathan Guyton, principal at Cornerstone Wealth Advisors, a fee-only advisory firm in Minneapolis. In addition to his financial advice practice, Guyton has contributed valuable research in the retirement planning arena. Among his best-known pieces of research are "Decision Rules and Portfolio Management for Retirees: Is the 'Safe' Initial Withdrawal Rate Too Safe?" as well as "Decision Rules and Maximum Initial Withdrawal Rates," which he coauthored with computer scientist William Klinger. He currently serves as a retirement planning columnist for the Journal of Financial Planning, and he's also an expert panelist on retirement for The Wall Street Journal and an online columnist for Time and Money.

Background Jonathan Guyton bio

Retirement Planning Amid the Pandemic Cornerstone Wealth Advisors' first-quarter commentary

"Amid Market Chaos, Strategies for Your Retirement Savings," by Anne Tergesen, The Wall Street Journal, March 7, 2020.

Retirement Withdrawal Rates "Decision Rules and Maximum Initial Withdrawal Rates," by Jonathan T. Guyton and William J. Klinger, Journal of Financial Planning, March 1, 2006.

"Decision Rules and Portfolio Management for Retirees: Is the 'Safe' Initial Withdrawal Rate Too Safe?," by Jonathan T. Guyton, FPA Journal, October 2004.

"The Original Retirement Spending Decision Rules," by Wade Pfau, Forbes.com, Nov. 8, 2016.

"How Retirees Can Spend Enough, but Not Too Much," by Ron Lieber, The New York Times, Aug. 28, 2009.

"Avoid These Mistakes With Discretionary Income in Retirement," by Jonathan T. Guyton, MarketWatch.com, March 15, 2017.

"Estimating the True Cost of Retirement," by David Blanchett, Morningstar, Nov. 5, 2013.

"Why David Blanchett's Retirement Spending Research Is a Big Deal," by Jonathan Guyton, Journal of Financial Planning, May 1, 2016.

Tax Planning "When a Roth IRA Is a Wrong Choice," by Jonathan T. Guyton, The Wall Street Journal, May 12, 2016.

"Are IRA Conversions a Good Idea Amid Volatility?" by Christine Benz and Tim Steffen, Morningstar.com, May 12, 2020.

Transcript

Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, global director of manager research for Morningstar Research Services.

Christine Benz: And I'm Christine Benz, director of personal finance for Morningstar, Inc.

Ptak: Our guest on the podcast today is Jonathan Guyton, principal at Cornerstone Wealth Advisors, Inc., a fee-only advisory firm in Minneapolis. In addition to his financial advice practice, Jon has contributed valuable research in the retirement planning arena. Among his best-known pieces of research are "Decision Rules and Portfolio Management for Retirees: Is the 'safe' Initial Withdrawal Rate Too Safe?" as well as "Decision Rules and Maximum Initial Withdrawal Rates," which he coauthored with computer scientist William Klinger. He currently serves as a retirement planning columnist for the Journal of Financial Planning, and he's also an expert panelist on retirement for The Wall Street Journal and an online columnist for Time and Money.

Jon, welcome to The Long View.

Jonathan Guyton: It's great to be here.

Ptak: So, the first question we have for you is where are you and your team working during the pandemic?

Guyton: Well, we've been working remotely for two-and-a-half months now. It's hard to remember almost when we were not working remotely. It's not as different as maybe that sounds. We've had the ability to do that for several years, and everyone has at some point. What's different is that we are all doing it all the time. But I'm still the one that goes into the office to check the mail and make sure that the plants are still doing well.

Benz: Do you expect that this might have a permanent impact on the way you work with clients? Presumably you're seeing them via teleconference or something like that. Do you think you'll continue some of that into the future? I mean, obviously, for the foreseeable future, but beyond that?

Guyton: Right. We don't know, but in a sense, it's less of a change for us than you might think. Cornerstone has clients in over 25 different states who do not live in the Twin Cities where we're located. And so, we have always had virtual or phone meetings with a whole bunch of those clients. What's interesting is that we're now starting to see some of them on video when we didn't before, and whether or how long that continues, we really don't know. But there's no real reason for us to be back in the office until we're able to meet face to face with clients. And they actually get the main vote on that one.

Ptak: Have clients responded differently than you would have expected during this period? Have there been any surprises?

Guyton: I think the biggest surprise was that when the things really started unfolding that we're going to have some potential financial impact on them, and now we're talking about back in February and March, we found that when we presented webinars and reached out with additional communication that the feedback we got was, yes, this is what we've talked about all the way along. We understand what you're doing or what's happening. It's really following along with that. And I guess in some ways, even though the pandemic has been, for some communities and for some people who have been affected, it's been a horrifying experience, a life changing experience, but from a financial planning and investment management perspective, it's really been a textbook bear market, where if you just did the stuff you always know that you're supposed to do and you implement effectively, you've really fared OK.

Benz: What strategies have you arrived at over the years that you find help keep clients calm during periods like we had in sort of the March period? You mentioned that you've been doing webinars. What other sorts of contact do you have with clients during periods like that?

Guyton: Well, we follow--everything that we do with clients that we implement with them has some backing in empirical research. And when we deviate from that, we tell them that we ought to have a really good reason for why we do so. So that's been a tremendous grounding. Another element is that when clients know that they have a plan, and when they know that that plan or the strategy that they're following can let them know when they need to make a change, how much of a change to make, and when, if necessary, they need to make some further change, that's really helpful. An analogy that we use is, it's like, if you're a ship, and you're at sea, and you're in a storm. What matters isn't what happens right there. What matters is what happened when the boat was being built. Was it built solidly? Was it built to withstand that type of situation? Does it have a crew in place, making decisions, who really have been through this before? And I think that's--I believe that's really been helpful to clients.

What's interesting is, we've probably had more contact from prospective clients in the last three or four months than any three- or four-month period I can remember in a long time. And so, we've gotten to see some differences. We've gotten to see how people who have been doing their best in these times have reacted. And we've seen some pretty striking differences and unfortunate outcomes for some of those.

Ptak: You mentioned before that a lot of what you do, or as much as possible is founded on empirical research. But if you depart from that, you'll inform clients. Can you maybe give an example of each, something that's very fundamental to what you do for your clients that's founded in an empirical research in a recent example, where maybe you had to call an audible and do something that wasn't as supported by research, but you thought there was an imperative to do so?

Guyton: Sure. Well, on the kind of the normal way we do things, I'll give an example based on retirement withdrawals. But I'll start with an example based on portfolio management, which would be true for anyone, whether they're retired, whether they're about to retire, or whether they're many years away from that life transition. And that is that, coming out of last year we didn't know that we were going to have this pandemic. But we did know that markets were highly valued by basically any measure. And so, having portfolios a little bit more toward the conservative end of their target allocations toward equities just made sense to us. That turned out to be really helpful, but it isn't because of anything that we could have foreseen.

Secondly, for those clients that have a balanced portfolio that includes some fixed income, we know that the main purpose of fixed income, especially if you're retired, is to have that portion of the portfolio hold up and be unaffected, when all hell is breaking loose elsewhere. And so, we had those kinds of bonds already, basically government securities. And so, they performed exactly the way we would have expected, even as corporate and municipal securities experienced some really shocking volatility.

The third thing is, when you get a dramatic downturn, it's an opportunity to rebalance. And so, we put in place a strategy where we anticipated that the markets would drop at least 30%. And we said, if we see that, we're going to go. That's when our target--we use limit orders with exchange-traded funds, which made it really easy, but we put those in place and we just waited for those prices to be hit. And it worked. That's all textbook stuff. But it makes a huge difference. We've been working with one prospective client just on their planning, but we've gotten to see their portfolio over this time through the end of May--and these are very similarly allocated portfolios--they're down about 12% for the year; our client portfolios are down 2%. And the only differences are those things that I just mentioned, withdrawal strategies.

There are a number of methodologies out there that all have been subject to empirical research. We happen to use one that I was involved in the research on with William Klinger back in 2006 that basically said, you can take more money out sustainably if you're willing and able to be a little bit flexible in what you do. And so, we just applied that. It's the same strategy that got our clients through the Great Recession. And at least so far, things haven't been as dramatic this time.

Now, to your question about, you know, calling an audible or pinch hitting or doing something out of the norm, I really don't have a good answer except to say, I can't think of anything. And I think anyone in this situation so far that said, I'm going to go against what would be the smart stuff to do because I think this time is different. So far, it has not panned out and like I illustrated, there are some significant financial differences in the results that people have seen.

Benz: Jon, a lot of your work has focused on the whole withdrawal rate system. And we want to spend more time there. But before we get into that, just want to follow up on a comment you made about fixed income. And you did write in a report to clients at the end of the first quarter that you had taken their fixed income assets 100% to government bonds, up from 50% previously. So, I'd like to just discuss, I guess, why you did that, but also whether you're still positioned that way with respect to fixed income assets.

Guyton: We are still positioned that way. The reason why is that, you know, when you--and this is particularly true for retired clients or clients soon to retire, and of course, that's when your portfolio is going to start to lean more toward fixed income, of course--and all of the research when you look at studies around sustainable withdrawal spending, when the models are set up, and the simulations are run, the bond allocation is always government securities. It's cash and government securities. And if you stop and think, well, why is that? It's not because you get higher withdrawal rates if you use corporate bonds. It's the opposite. It's because at those times when you need to leave your equities alone, let them recover, don't sell them. Take your withdrawals out of the other portion of the portfolio. It is vital at that time that those bonds not be correlated with the negative returns that we saw--that are going on in the equity markets.

It's funny--one of the largest core bond fund producers in the country said something they were trying to get us to use their core bond fund and they said, you know--these are their words--they said we are for when bond funds need to act like bond funds. We provide shock absorbers uncorrelated with the equity markets. Well, you know what, in the middle two weeks of March, they were down 7% at the same time when stocks were down 20%. Now, stocks went down more than that, but in this particular two-week period. That is not what your fixed income needs to do at a time like this. And so, when we knew that things were getting crazy, and frankly, we didn't know where the bottom was, who knows what's going to happen next, we're sitting here talking on the first week of June. It's really important for clients to know that they have multiple years' worth of withdrawals that they can fund that are currently held in assets that have the greatest chance of being unaffected. The next time the market decides to go down 20% or 40%, or whatever that is, and in volatile times like this, that becomes even more important than in a time like say a year ago.

Ptak: How do you grapple then with the issue of negative real yields? Government securities, obviously, they do boast the qualities that you described before, but at the same time when I look across the yield curve, you've got negative 30 to negative 55 basis point real yields on sort of treasury instruments. So, how do you grapple with that?

Guyton: Well, I'm glad you asked that question. Because if you look out over the next 10 or 15 years and you have a bond allocation, if your goal is to maximize return, you would probably hold your bond allocation a little differently than I just described. But that is not what is going on for retirees. Because every single month or every single quarter and every single year, retirees need to have a portion of money that they draw out of their portfolio, it's a part of their retirement plan. And what we find with many people who have been quite successful in the accumulation phase of their life, when they get into the retirement phase, there are certain things that change. And the biggest thing that changes is the role of bonds.

The most important things that bonds can do is not to generate a yield. The most important thing they can do is to be unaffected during that period of time when you don't want to sell stocks. Now, right now, that doesn't look like it was a very long period of time. But if you go back to the tech bubble, from the time of the market peak until the time of when the actual recovery began, that was two-and-a-half years. And it took several more years to get back to the point where stocks had risen to where you would want to sell them. The same was true in the Great Recession. We think of that as 0'8-'09. But the stock decline started in '07 and didn't get back to where it was in '07 until 2012. So, just having a few months or a year or two in cash didn't get you through. You needed to have that money that never went down in value, because all your returns are really going to come from stocks anyway. So, I'm not concerned about those yields that you mentioned, those real yields as long as the bonds that are generating them hold their value. I mean, all you need to do is look at total returns in bonds for the year, particularly during that time before the market had started to recover. And it was very clear the bonds that were going to serve retirees better.

Benz: You mentioned that you build kind of a runway for clients of x years of portfolio withdrawals if they're retired. For your typical retired client--of course, there's no typical client. But can you talk about how many years' worth of portfolio withdrawals you would hold in cash and government bonds?

Guyton: Well, we don't hold very much cash. Because frankly, there's really no difference between cash and a one or a two-year treasury. But for those kinds of safe things, when you look at history--I mean, you look at the history I just mentioned. In the Great Recession, there was a period of time of as much as five years when you would have wanted to be taking your withdrawals from something other than stocks. And when you look at safe withdrawal research, there's a reason why the allocation sweet spot that gets the highest sustainable withdrawal rate is somewhere between 60% and 70% stocks, which of course means 30% to 40% bonds. I mean, why do you need 30% to 40% bonds? Why not 20%? Because you expect that that would give you a higher return.

So, why do you get a higher withdrawal rate when you have bonds up in the 30% to 40% range? The answer is, because markets can give you a time period where you want to be laying off the stocks--use their dividends for sure, but lay off selling stocks and live off selling bonds if you need to, to get all the way through that time period. And so, if I have 30% of my money in bonds, and I am taking out, let's say, 5% per year, well, 5 goes into 30, 6 times, that's six years' worth of withdrawals. If you consider that there are going to be some bond interest, a little bit, and there will be some dividends, that's going to stretch you out to seven or eight years that you can get through before you would ever have to sell a stock or an equity holding in order to provide next month's or next year's withdrawals. The research tells us that's where the sweet spot is, and I'm certainly not going to go against it. So, that's why we see, unless clients just don't need as high a withdrawal percentage, we see almost all of our clients in a portfolio that's targeted to have somewhere between 30% and 40% in fixed income.

Ptak: And so, flexible withdrawal strategy, which you've already alluded to at least once during the conversation and about which you've written and conducted a lot of research, it sounds like is really important to sort of the operationality of that framework, is that so and I guess my second question is, how do you inculcate your clients in a flexible withdrawal approach when perhaps many of them are accustomed to thinking of withdrawal is sort of a straight line type of rate?

Guyton: Right, right. Well, you know, it's funny, because I think one of the things that has helped me the most is that my full time work is not as a researcher, or a writer, or anything like that. I'm a practitioner. And so, I get the chance to have retirees teach me and teach my colleagues what it's like to actually put this stuff into practice. And then we can adopt the way we implement things in a way that matches their behaviors, their lifestyles, and the emotions that affect their decision-making.

So, when you think about someone who is--we'll just make up a little scenario here. They're 65 years old, and now they're going to retire. And if they've made choices along the way, where they have put money away for retirement, we know that over the last 40 years they have had variations in their income. Somebody takes time off because they have a baby, somebody gets a bonus, somebody takes a leave of absence, somebody gets laid off, there's an illness. And so, people have 40 years of learning how to be flexible in their spending decision. And so, what we realized was that doesn't go away when you're 65. That's the only thing you know how to do. And so, the idea that retirees would have the ability to have some small amount of flexibility in their spending is actually something that lines up with people's real-life experiences.

And so, the work that I did basically said, since that is true, if we factor that into the idea of sustainable withdrawal approach over one's lifetime in retirement, does that make any difference to the amount of money that you can take out because of course the previous research had always said, every year you get a raise for inflation come hell or high water. And that is actually not the way retirees look at things. And the only reason we're talking here today is because that research revealed that if there can be a little bit of flexibility, then yes, you can turn the faucet on a little bit more and take more money out sustainably as long as you're willing and understand the adjustments that you need to make along the way when they're called for.

Benz: You worked on some what I would consider seminal research, this idea of a system that would allow for fluctuating portfolio withdrawals. So, a question is how people can implement this and I think people stumble on this. I saw a query on an investment message board where someone said, can someone explain Guyton Klinger to me like I'm 5. So, let's start there. Let's just talk about how in layperson's terms you would describe the strategy that you've researched.

Guyton: Yeah, I saw that post too. I thought, well, I guess when you're 5, don't know how to Google me and send me an email. And I thank you for your comments, Christine. That's really, really too kind.

So, if you start with the idea that instead of taking out 4% safely, that that's what you do every single year forever and you just give yourself a raise for inflation. If you say, OK, I'm willing to have some flexibility and I'm going to start at a 5% withdrawal, which is--I mean, that's 25% more money. So, that makes a real difference. It's important to know that your withdrawal percentage, which is what we call your withdrawal rate, is something that you can measure every single day. I don't do it every single day, but you can do it at any point in time. It's just how much money are you taking out regularly this year, divided by what is the portfolio worth whose job it is to generate that income. You get a percentage--$50,000 of withdrawals on $1 million portfolio is 5.0%.

And so, you track that. That withdrawal rate is like the temperature. It can get too hot or it can get to the point where it's too cold and it could be warmed up a little bit. But right now, we're talking about when it gets too hot. And that is when that $50,000 is suddenly only being supported by let's just say $800,000. That drives the percentage up. And we all know that if that portfolio value keeps falling, falls too fast, doesn't recover fast enough. We know that any withdrawal strategy can get in trouble. So, we have what we call guardrails. And if you think about driving your car down a road, you hit a guardrail, it does two things. It puts a ding in your car, and it changes your momentum so that instead of the momentum is pushing you toward the edge of the road, it now starts to shift you back toward the middle where it's safe.

So, if that 5% withdrawal rate gets 20% higher, which would be 6%, if you hit that number, that's a warning, that's the guardrail and you say, I'm going to take that $50,000 down by 10%. So, I reduce it to $45,000. And that's all you need to do for a year. You can measure your withdrawal rate the next day if you want, but what really matters is a year from now. If it's still under 6%, you're fine. Keep going, give yourself a raise for inflation. But if it gets back up over 6%, it's like you hit the guardrail again. You need to adjust it down another 10%.

Now, in the pandemic, we have not actually seen that guardrail be hit. We got close toward the end of March. It was hit in the Great Recession, but that's really how it works and that's kind of what that medicine is. And I just want to add that a lot of times when retirees hear that notion reduce what you're taking up by 10%, what they think that means is reduce what I'm spending by 10%. And that's not true. Because your Social Security didn't go down, and your pension didn't go down. And furthermore, that $5,000 of reduced withdrawals, that's $5,000 that you can reduce from what you're withdrawing from your IRA or 401(k). In other words, that's $5,000 that isn't on your tax return. And so, guess what? Your income taxes are lower. Maybe your income taxes are $1,500 lower. So, that's not a $5,000 reduction in spending. It's $3,500, 300 bucks a month. Will that make a difference? Yeah. Will it cause you to have to change your lifestyle? I doubt it.

Benz: So, one shortcut I've heard on this general idea is simply foregoing the inflation adjustment. So, taking the 4% inflation-adjusted annually but not doing the inflation adjustment in the bad market years. Does that help address what you're talking about or not quite?

Guyton: Well, it does. The key with your 4% example is that you actually are not withdrawing as much as you could if the medicine you were willing to take included those reductions. But the flip side of that is, if you're not willing to slow down your withdrawals, then your withdrawals can't start out as fast to begin with. I mean, there's no free lunch here. You either have to be willing to play by those safe withdrawal rules. Or if you don't want to, then you have to start out with a lower withdrawal rate. So, those early withdrawal studies are correct, if that's the behavior you want to follow. And clearly, foregoing an inflation adjustment, it takes a little pressure off the portfolio and it's only going to leave you with more money at the end.

Benz: You presented some work at a conference I was at last year where you talked about this idea of a discretionary fund that you were using for clients to help them manage discretionary unplanned expenses. Can you talk about how you arrived at that idea and how you've been using it with your clients?

Guyton: Yeah, it's because we didn't want to be the bad cop anymore on our clients' retirement dreams and bucket lists. But it's another example where we learned a lot from watching retirees. And if you think about it, it kind of lines up exactly with what we think is true. David Blanchett at Morningstar was involved in some great research that looks at retirement and retiree spending over one's retirement lifetime and showed how it declines in real terms. But what we also know is that early in retirement and quite frankly, for a long time in retirement, hopefully, people will have their health, they will have families, they will have bucket lists, they will have things they look forward to doing and all of these cause early retirement spending to be a lot more volatile from year to year.

And so, the idea is, on the one hand, retirees, they want to play by the rules. They don't want to do anything that will damage their long-term financial security. And at the same time, they want to enjoy life today and do the things that really add to the quality of life in their retirement. But they also want to know where the line is, where they're doing too much, or where things start to become unsafe or where that sustainability comes into question. And so, imagine a situation--go back to my prior example, where someone's taking out $50,000 a year on that $1 million. What that means is, to support each $10,000 of spending, you need $200,000 in a portfolio whose job it is to do that for your lifetime. Now, let's suppose that some year, a retiree says, well, we want to spend some extra money. We wanted to do something with our kids, or we want to do a big home improvement, whatever that might be.

And so, what we said is, OK, instead of getting $50,000 a year out of $1 million, how about if you get $40,000 a year out of $800,000. And that leaves another $200,000 that you can spend in any way that you want. And by doing that, what we said is, we'll follow the rules with the $40,000 a year withdrawal. Whatever method that was, stick to those and follow those rules in a way that maximizes your chance that this is going to be secure and sustainable. But then, with that other $200,000 knock yourself out, spend it over the next five years or 10 years or make it last for 20. However you want to do that. When it's gone, it's gone. But there you know where the line is, and now you get to make the decision about what is it worth using that extra money for that's going to have the most meaning to you.

What we found is that it's incredibly empowering for people for those reasons that I mentioned. I didn't sit there one day and dream up that this would have these implications. We just tried it with a couple of clients and then learned from their experiences and so much so that I think every client of ours who now retires, ends up with this structure that facilitates that kind of freedom in their spending.

Ptak: So, maybe can you quickly review how you size that? I think you described in your example a way you arrived at the number, but I have to think that it would vary client by client depending on different factors. And then, also, can you talk about what the experience is like with a client who is close to depleting that fund, how they behave and what sort of accommodations you might have to make in a situation like that?

Guyton: Right. Well, Jeff, you put your finger on what I call one of the dirty little secrets of retirement planning, which is, when they get close to depleting it, they don't like it and hopefully, they're still in good enough health where they could take advantage of having it be bigger. So, when that occurs, what we have the ability to do is kind of recalibrate things. We could say, oh, well, you know, we started this when you were 65. But now you're 73. And so, we can review what that core ongoing spending needs to be. And we might say, oh, OK, based on this revised number, that lifetime core portfolio doesn't need to be quite as big as it is right now. And so, the excess can actually go to restock the discretionary fund. Now, there's no guarantee that that is going to happen, but it is a possibility. After all, the only reason why Bill Bengen came up with 4% and not 4.3% in his original study, was because there was one scenario where 4.3% didn't work, and he wanted to be sure it was safe in all the cases. At a given probability of success, the rate is low enough that it gets you through all those tough times. And for most retirees, their scenario isn't quite that tough. And so, they actually don't need as much money in that lifetime portfolio as they think. So, that recalibration down the road, like, we're eight years in and we realize, oh, it hasn't been the worst-case scenario. So, that's what can happen when things are depleted.

But to your first question, what a lot of times happens in retirement planning, and I see this from financial planners, as well as, do-it-yourselfers who have invested a lot of time in educating themselves is that people confuse what we call a core expense from a discretionary expense. It's easy to think that core is necessary and discretionary is fun. But that's actually not what happens. The key to a core expense is it's a category that's going to be there in some form at a given level every year for the rest of your life. Food obviously comes to mind, and insurances and taxes and such. But think about housing. I might live in a house right now where it's paid for, but between the property taxes, the insurance, the maintenance, the utilities, I have a cost in my budget that's going to go on forever and it doesn't matter whether I move to an apartment or a condo or assisted living or whatever, that expense is going to be there in some way for the rest of my life. Those are core expenses.

Discretionary expenses are those that are only going to be there for a portion of the rest of your life. Now, it might be 60% of the rest of your life, but that's not the whole thing. Or it's an expense that's going to be there for most of the rest of your life, but you know it's going to decline over time. It doesn't need to maintain its current level. And so, what that means is that when people are deciding how much regular lifetime income they need from their portfolio, they tend to overstate it. Because what they put in there are expenses that are going to actually come down over time. And they fund them as though they are going to need to be there forever at the current level. Some expenses are that way, but not as many as people think. And so, they end up in this dichotomy between a core portfolio and a discretionary portfolio, putting too much in the core versus the discretionary. So, if we can help people see those distinctions in their spending, then we can get a better balance of that. But it all comes down to those two different descriptions and characteristics of spending.

Benz: One issue that I would guess would come up a fair amount with respect to the discretionary fund is aid to adult children. Can you talk about how you navigate that with clients where you think that perhaps they're overextending financial aid to adult children?

Guyton: Yeah, that's a tough one, because it's definitely in that discretionary category. Adult children go through a tough time and parents want to help them out and feel they don't have a lot of choices, at least for the time being. And the reality is that that ends up using up money in that discretionary portfolio that they would frankly rather spend in other ways. But the one thing that structure does help with is at least clients know. They know that the core portfolio that's generating a certain amount of income every year, that if they start to cheat, and they say, oh, we can take a little extra out of that, then they just can't be as certain that that money is going to be there for as long as they need it to be. So, what we say is, don't cheat. Don't change the rules. Don't take extra money out there. Take it out of the discretionary, use that as you feel you need to. We can look at recalibrating things more often and do so if we need to. But it's just one of those factors of life that sometimes you need to put money toward things that maybe wouldn't be your first choice. But given the circumstances, it's really the only choice.

Benz: You've written about the bucket approach, cautioning that it can lead to unrealistic expectations and questionable interpretations. Let's talk about some of those issues, some of the sort of red flags or yellow flags that you've raised in relation to a bucket strategy?

Guyton: Well, one of the things that I appreciate about the bucket strategy, and I know your advocacy for it, Christine, among others, is that it has as kind of its foundation point a way to help people see the levels of security and stability and the income for the next period of years, that really can be protected from market downturns, whereas other monies have different characteristics, because they're invested differently. So, whether someone uses a bucket approach or a railroad car approach or a single portfolio approach, I would be in favor of it as long as it can do three things, that it does those three things for that particular retiree better than any other approach.

First is, it needs to make clear how much money you have and how many years of withdrawals can be funded until you have no choice but to sell some of your equities. The more people understand that and can see that in their holdings, the better off they are and the better decisions they'll make.

The second is, clients need, and retirees need to know from where they're going to take their withdrawals. At any given point in time, there's a better place to take it than others. Let's forget the volatility of the last few months. Let's say that in the last six months, the stock market has gone up 6%. Well, that's going to have an effect on where your next set of withdrawals should come from. Or if the stock market has gone down 6%, that's going to have an effect probably on where you should best take those withdrawals. And so, as long as your approach allows you to make good choices about where those withdrawals come from, that's really important.

And the third thing is that there are going to be times where in order for your portfolio to stay in line with kind of the underlying research or the underlying principles that you're basing it on, you're going to need to rebalance. Sometimes that means you need to move money from equities to fixed income. And sometimes you need to move money from fixed income to equities. And so, if the approach you use makes that clear and allows you to do those things when they should be done, then it's serving you well. And if it makes it harder to do that or doesn't make it as clear when you need to do that, then it's not. So, those three things are really what seemed to be key to me.

Ptak: Shifting gears a bit, I'm curious whether given the circumstances, you and your clients have altered plans that they might have made for later in life living circumstances or care that they would have received, given the fact that we've seen COVID ravage nursing homes and assisted living facilities. Perhaps there are some of your clients who are reconsidering plans that they might have made at an earlier juncture. Is that a conversation you've been having?

Guyton: Well, it's a great question, and it's probably a little premature. I have to tell you that no one's really brought it up because the focus has been so much on the immediate situation. It's always been true that as people have thought about where they want to live as they continue to age and as their health changes and eventually declines, if that's the path they're going to be on, that people want to stay as independent as they can, for as long as they can and in their home for as long as they can. And I don't believe that is going to change.

And so, the thing with respect to that is that when a retiree has a sustainable income amount, some combination of Social Security, maybe a defined benefit pension, certainly withdrawals at a given level from their portfolio, it doesn't matter what their health situation is, that same income amount is there. And so, a lot of times people think of these expenses as they're brand new. It's like, we don't have these extra care expenses. We'll have them in the future. We've never had them before. But when life gets to that stage and you have those new expenses, you also have a lot less of other expenses.

And so, what we find is that retirees who have planned well, probably don't need a separate fund to fund all of these new expenses, all these care expenses because their irregular income actually will go farther than they think that it will. Now, what people might say is, you know, I want to be sure that there's enough money for five years of 24x7 care in my home. I don't want to be in a situation--it used to be that if I needed to go into a care facility, that I would be OK with that. But if I wanted my own home until my dying day, that's more expensive. And so, it would mean things like, well, you can't have as much money for regular spending today because either you need to buy a more expensive long term care policy, or you need to set aside--it's not another discretionary fund, but it's a fund that you would draw on should that series of events occur, and that means that that money is off limits for spending today.

Benz: What percentage of your clients would you say are the clients maybe who are in the 50 year age range and above, what percentage would you say have some sort of long term care insurance versus those who are planning to self-fund long term care expenses?

Guyton: About 50%. And the difference is, if we know that somebody's core expenses are going to require basically all of their money at the highest sustainable withdrawal rate, that doesn't really--and they say, that's what we want to do--then we know that there's not extra cushion for a period of time when they might need to lean more heavily on their assets. And since they really shouldn't plan on that, they need to have another source of money in case that occurs. And that's what leads to long term care insurance to fund that portion of the care that it's not realistic to think that their regular retirement income can cover.

Benz: So, would you look at like a pure long-term-care insurance policy or one of the hybrid life/long-term-care products?

Guyton: Probably more the traditional simply because we want to be planning for that, if you will, financially catastrophic event that takes as little money off the table as possible out of the spending the clients want to do today. But in a case of a couple, one provision we would very much want is for the couple to be able to share the benefit, because for a couple, the real long-term-care risk is that one of them has a major decline in health, has extra care expenses, passes away, and then leaves their surviving spouse to live for another 10 to 15 years. And that just can't happen with reduced assets. So, that's why having that pile of money in the long term care policy available to whomever needs it first is key.

Ptak: We've talked about some aspects of how you allocate, invest and withdraw on behalf of your clients. Can you talk more specifically about how you choose them investments to fill out the different sleeves? Maybe it's active versus passive or the various types of vehicles that you use to implement on their behalf.

Guyton: Yeah, well, there are a lot of directions to go on that. But I think once we determine the overall allocation, stocks versus bonds that it's going to be needed to generate the kind of returns to fund their withdrawal strategy. Then what we do is we take the notion that you will say, mix of global investments is this way, the U.S. makes up about 60% of it 40% is foreign. In the U.S. about 80% is large cap, 20% is small cap. We say, well, that's our starting point. Now, from that we will adjust based on tactical or strategic things that we say. Our clients have had less than 30% of their equities in international for the last few years. But that was a strategic decision that we made.

Once we go to fill those sleeves, as you mentioned, our view is that the burden of proof is on active managers to show that in their asset class, large versus small value versus growth, core international versus emerging markets, in that specific asset class, that they're worth the money, that they have a compelling record of beating what we can get if we just buy an exchange traded fund. So, the way that seems to shake out right now is about 25% to 30% of our clients' equities are in actively managed holdings, and the rest is in asset-class-specific ETFs. And I'll add that what that's allowed us to do, for better for worse, because expenses are not the only thing but our clients' overall portfolio expenses, you know, the internal expenses and the holdings that they have, come out at right around 20 basis points.

Benz: Do you think employ any factor tilts in your client portfolios? We've been talking to a number of guests who are quite bullish about the prospects for value stocks, for example. Are you doing anything like that?

Guyton: We've always used some of that. It started to be called smart beta and then it was factor tilts. We've had a little bit of a leaning toward growth versus value. But that is definitely a consideration we look at. And it's very rare that those growth value factors are even in what we do. And I suspect that that will continue to be the case.

Ptak: What about munis and the role that they play in what you do for clients? Munis went through a very, very difficult patch until the Fed stepped in and so did they figure prominently into what you would do in the taxable side for your clients?

Guyton: Yeah, and corporate bonds had the same story to tell, didn't they?

Ptak: They did.

Guyton: Yeah. So, this kind of leads to some tax planning things which is really becoming the Holy Grail of retirement planning in general right now. And so, when you look at where are you going to hold certain assets in your portfolio, there's a lot of compelling reasons to have most of your fixed-income holdings in your tax-deferred accounts, your 401(k), or your traditional IRA, versus a Roth IRA. And so, if that's going to be the case, well, that leaves munis out.

But let's say you have a case where for whatever reason, most of a client's money is in an aftertax account. And there's relatively little that's in a traditional IRA or 401(k). You could make the whole IRA be bonds, but maybe that's only 20% of the total and your target is 35%. So, you got to put some more bonds somewhere, and in that case, we would never put it in the Roth. We would put it in the brokerage account. And in that case, we'll look at a client's marginal tax rate and if munis make sense, then we would hold it there. Having said that, however, when we saw what occurred with this great amount of uncertainty economically and obviously states and municipalities have been hugely affected, and we still don't know the full effects of what that's going to be. We currently have all of those holdings on the U.S. government side right now. But when some of that uncertainty starts to go away in those situations, yeah, you bet we'll be back with general-obligation municipal bonds and such because they've proven to be in most cases very reliable and do what we want them to do.

Benz: Speaking of tax planning, we're in a year in which required minimum distributions from IRAs are suspended. And so, there's been a lot of chatter about whether retirees should consider converting some of those traditional IRA assets to Roth, maybe take advantage of a low tax year to do so. Is that something you've been counseling some of your clients to do?

Guyton: Well, we've been counseling clients on that for over a decade because there is no bigger factor in how far your wealth will go. Assuming that you don't do really dumb things on the investment front, if you just play it straight, and you're relatively competent there, the tax planning and the tax decisions that you make year in and year out is where it's at. And what's vital to understand with all of that money that a retiree has in their IRA or 401(k), is that money is going to be taxable to somebody at some time. The only exception is any portion that you choose to leave to charity. So, if it's going to be taxable, at some portion to some time, the question becomes, well, when can you pay the lowest rate of tax?

So, when you think about a retiree--and I'm going to take a retired couple because of a point I want to make. There are really three different scenarios under which that money can be taxed. One is when the couple is alive. Secondly is when one of those has passed away and the survivor now has to file as an individual taxpayer, where the tax rates are much higher at any given income level. And the third scenario is money leftover that goes to kids or other humans. And it used to be that you could stretch that out over the beneficiary's remaining lifetime, but now that's compressed to just the next 10 years under the SECURE Act that was recently passed at the end of last year. And so, when you look at those three scenarios, you have to ask not just what is your tax rate today, but what's the marginal tax rate going to be in each of those scenarios.

So, if I have a chance today to fill up the 22% or the 24% bracket, obviously the 12% bracket, that is almost certainly going to be a lower rate than what will occur down the road when RMDs are back again, and maybe those RMDs are going to cause me to have to pay higher Medicare premiums in the face of these IRMAA surcharges which can add 3 or 4 percentage points to your marginal tax rate. We see cases where a married couple is in the 22% bracket, but then somebody dies. And by the time the survivor keeps the larger Social Security check, all of the IRA money remains and the RMD amount is basically the same. But suddenly that survivor goes up to the 32% bracket, because you can only have half as much income in each of the brackets before you move to the next one when there's only one person versus two.

So, if I have the opportunity this year or any year to pay taxes on a portion of that money at a lower marginal rate, then I believe will be the case in one of those other scenarios. I should do it. But it's never the case that you should do the whole thing. And because of the way our tax rates are structured, we have seven different tax brackets. But the key is they are in three groups. There's low, middle and high. And there are huge jumps when you move from one to the other. The highest rate in the low tier is 12%. But then the low one in the middle goes all the way to 22%. The highest rate in the middle is 24%. But the lowest one in the higher tier goes all the way up to 32%. So, you would never want to cross one of those lines from 12 to 22 or from 24 to 32, unless you foresee a time down the road, where someone is going to be in even a higher marginal rate at that point. So, in a sense, the tax planning question and calculus isn't any different this year. It just opens up more room to do things that you couldn't do last year, and you're probably not going to be able to do next year. But it's that time between retirement and age 72 when RMDs start. Now, that is the sweet spot for tax planning. You can correct a lot of things about your tax situation that you don't like in that period. But once you hit 72, it becomes a lot harder and a lot more expensive.

Ptak: Well, Jon, this has been a really enlightening conversation. Thanks so much for sharing your time and perspectives with us and our audience. We've really enjoyed it.

Guyton: Well, thank you, Jeff. And Christine, I'm so glad you asked me to join and it was a pleasure to be with you this morning.

Benz: Thank you, Jon.

Ptak: Thanks again.

Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts.

Benz: You can follow us on Twitter @Christine_Benz.

Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at [email protected]. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)